Committed facility

What Is a Committed Facility?

A committed facility, in the context of corporate finance, is a formal agreement by a lender (typically a bank or group of banks) to provide a specified amount of credit to a borrower over a defined period, subject only to certain pre-agreed conditions. Unlike other forms of credit, the lender cannot unilaterally withdraw the funds once the commitment is made, even if the borrower's financial health deteriorates, as long as the borrower remains in compliance with the loan agreement and its associated covenants. This type of arrangement is a cornerstone of corporate liquidity management, falling under the broader category of corporate finance and lending. A committed facility offers a reliable source of funds, providing stability and planning certainty for the borrowing entity.

History and Origin

The concept of committed credit arrangements has evolved alongside the increasing complexity of corporate financial needs and the development of the banking sector. As businesses grew and their funding requirements became more sophisticated, particularly for ongoing operational needs or large-scale projects, the demand for guaranteed access to capital emerged. During periods of economic uncertainty, access to reliable funding became critical. For instance, the significant role played by committed credit lines during the 2008 financial crisis highlighted their importance, as many nonfinancial firms drew heavily on these pre-arranged facilities when other short-term funding markets dried up.⁴ This underscored their function as a crucial source of liquidity in times of systemic stress.

Key Takeaways

• A committed facility obligates a lender to provide funds to a borrower up to an agreed limit, provided the borrower meets predefined conditions.
• It offers financial certainty and serves as a reliable source of liquidity for corporations.
• Borrowers typically pay a commitment fee on the undrawn portion of the facility.
• The terms, including interest rate and covenants, are established at the outset of the agreement.
• These facilities are commonly used for working capital management and as backup liquidity.

Formula and Calculation

While there isn't a single formula for the "committed facility" itself, key costs associated with it often involve:

1. Commitment Fee: A fee charged on the unused portion of the committed facility. This compensates the lender for setting aside capital and incurring regulatory costs, even if the funds are not drawn down.
   $\text{Commitment Fee Amount} = \text{Undrawn Committed Amount} \times \text{Commitment Fee Rate}$
2. Interest on Drawn Amount: When the borrower draws on the facility, interest is charged on the utilized portion.
   $\text{Interest Expense} = \text{Drawn Amount} \times \text{Interest Rate} \times \text{Time}$

These calculations ensure the borrower understands the total cost of having the line of credit available, whether or not it's used.

Interpreting the Committed Facility

A committed facility is primarily interpreted as a robust liquidity backstop and a signal of a borrower's creditworthiness. For a company, securing a substantial committed facility indicates a strong relationship with financial institutions and a capacity to meet future obligations. The size of the facility relative to a company's needs, the fees charged, and the stringency of the covenants reflect both the borrower's financial standing and the prevailing market conditions. A large, long-term committed facility can significantly enhance a company's liquidity profile, reducing the risk of being unable to meet short-term liabilities. It also allows companies to seize unexpected opportunities requiring capital.

Hypothetical Example

Imagine "Innovate Corp," a growing tech company, secures a $50 million committed facility from a syndicate of banks to ensure flexible access to capital for expansion and unforeseen needs. The loan agreement specifies a five-year term, with a commitment fee of 0.25% per annum on the undrawn portion. The interest rate on any drawn amount is set at SOFR (Secured Overnight Financing Rate) + 2.00%.

In the first year, Innovate Corp initially draws $10 million to fund a new product launch. Later in the year, due to unexpected supply chain disruptions, they need additional working capital and draw another $15 million.

• Undrawn Committed Amount (initially): $50 million - $10 million = $40 million
• Commitment Fee (on initial undrawn): $40 million * 0.0025 = $100,000
• Total Drawn Amount: $10 million + $15 million = $25 million

Innovate Corp benefits from the committed facility because they could access the additional $15 million quickly and reliably during a time of need, without having to negotiate new financing under potentially unfavorable conditions. The banks were obligated to provide the funds, reinforcing the "committed" nature of the agreement.

Practical Applications

Committed facilities are widely used across various sectors for a multitude of purposes:

• Working Capital Management: Companies often use these facilities to manage day-to-day operational cash flow fluctuations, ensuring they always have sufficient working capital.
• Bridge Financing: They can serve as temporary funding until longer-term financing, such as bond issuance or equity placements, can be arranged.
• Mergers and Acquisitions: Businesses may secure a committed facility to fund a potential acquisition, providing certainty of financing before the deal closes.
• Contingency Planning: They act as a critical liquidity buffer against unforeseen market disruptions or economic downturns.
• Syndicated Lending: For larger corporations, committed facilities are often part of a syndicated loan, where a group of financial institutions collectively provide the credit. Data on syndicated loan portfolios, including undrawn credit lines, are regularly tracked by financial authorities.³ The total volume of syndicated loans to nonfinancial corporate businesses, often including these committed facilities, represents a significant segment of the financial market.²

Limitations and Criticisms

While offering significant benefits, committed facilities also have limitations and can present challenges:

• Commitment Fees: The primary criticism from a borrower's perspective is the commitment fee, which is an ongoing cost for funds that may never be used. This cost must be weighed against the benefit of assured liquidity.
• Covenants: Borrowers are typically subject to various covenants (e.g., financial ratios, reporting requirements) that, if breached, could lead to a default and termination of the facility, even if payments are current. Strict covenants can limit a company's operational flexibility.
• Bank Risk Exposure: From the lender's viewpoint, committed facilities expose banks to "pipeline risk" and the risk that borrowers will draw down heavily precisely when the bank's own liquidity is under stress, such as during a financial crisis. This phenomenon, known as a "liquidity crunch," can increase the inherent risks to banks associated with committed loan facilities.¹ Banks must carefully manage these contingent liabilities, which can impact their regulatory capital requirements.
• Moral Hazard: There can be a moral hazard where the certainty of funding might encourage riskier behavior from the borrower, knowing funds are guaranteed.

Committed Facility vs. Uncommitted Facility

The core distinction between a committed facility and an uncommitted facility lies in the lender's obligation to provide funds.

While an uncommitted facility offers flexibility without ongoing fees, it lacks the reliability of a committed facility, meaning funds may not be available when most needed. This makes the committed facility a more robust and essential tool for strategic financial planning.

FAQs

What is a commitment fee?

A commitment fee is a charge levied by a lender on the undrawn portion of a committed facility. It compensates the bank for setting aside capital and for the inherent credit risk and regulatory costs associated with guaranteeing the availability of funds.

Why do companies use committed facilities?

Companies use committed facilities primarily for assured liquidity, enabling them to manage day-to-day cash flow, fund unexpected opportunities, or have a reliable backup in case of market disruptions. It provides financial flexibility and reduces the risk of being unable to meet short-term obligations.

Are committed facilities always revolving?

Not necessarily. While many committed facilities are revolving credit lines (allowing funds to be drawn, repaid, and redrawn), a committed facility can also be a term loan where the full amount is committed but drawn down over a period or at a specific future date, such as for a construction project.

What happens if a borrower defaults on a committed facility?

If a borrower defaults on a committed facility by breaching a covenant or failing to make payments, the lender can declare an event of default. This typically allows the lender to accelerate repayment of any drawn amounts, charge penalty interest, and potentially cancel the remaining undrawn portion of the facility. The lender may also have rights to any collateral pledged.

How does a committed facility impact a bank's balance sheet?

An undrawn committed facility is an off-balance-sheet item for a bank, meaning it does not directly appear as an asset or liability. However, banks must hold regulatory capital against these commitments due to the potential future obligation to disburse funds. When a borrower draws on the facility, the drawn amount becomes an on-balance-sheet loan.